Amidst the hullabaloo of the possible government shutdown take-two and the confusion over the new tax code, the filing season has begun. The new Tax Cuts and Jobs Act (TCJA) is now into implementation. Early filers have started calculating their taxes and comparing them to last year. The difference is clear. Let us understand how the Act is affecting us.
‘What happened to my refund?’
This is the question countless Americans are asking. Early filers have taken to Twitter to express their views, and they do not seem happy about the fact that their refund amount has decreased, or they owe more money to Uncle Sam. The Act promised relief and taxpayers, especially Trump supporters, seem displeased.
The truth is, most Americans have become dependant on their refund cheque. They rely on that money to help their financial position. After the withholdings decreased last year, the refund was bound to get smaller. Experts say they had expected this, as a large refund means you paid more in the first place. But the taxpayers are shocked and confused.
The most recent IRS data shows average refunds running low by 9 percent compared to the previous year. The Democrats and independent analysts are criticizing the changes made, saying that they favor the wealthy more than the middle-class.
The US Treasury has said that the TCJA has cut taxes for everyone and the new system is more accurate. Smaller refunds actually mean that people are withholding the appropriate amount based on what taxes they owe. This basically means larger paychecks throughout the year.
The Realization after the Shock: Changes in Withholding
What happened to the refund? The change in the guidelines for withholding at the start of the year 2018. That is the amount withheld from paychecks for taxes you owe. Thus, even if your taxes have decreased, you might have a smaller refund or owe more money.
The US Treasury has estimated that several million more taxpayers (a rise from 18 percent to 21 percent) will owe money instead of getting a refund. And many will get a smaller refund, as they didn’t overpay this year. This realization comes as a nasty surprise.
How the New Tax Code Affects You
The TCJA was signed by President Trump on December 22, 2017, and is said to be a major overhaul in the tax policies. As taxpayers calculate their taxes now, the effects of these changes are slowly coming into light.
Here are some major highlights.
i. The tax rates of the existing seven tax brackets have been lowered. The highest bracket is $500,000 for single people and $600,000 for married couples with an income tax rate of 37% (lower than the earlier 39.6%).
ii. The standard deduction slabs have been doubled (approximately). Single filers get a deduction of $12,000 (earlier $6,350), while joint married filers get a deduction of $24,000 (earlier $12,700). It is estimated that most taxpayers will opt for a standard deduction to save time and effort. The experts predict that this huge move could harm the tax industry, and decrease charitable contributions (as fewer people will want to itemize their deductions).
iii. Personal exemptions have been eliminated. Earlier, a taxpayer could deduct $4,150 for each person claimed. This hurts people with large families, even with a higher standard deduction.
iv. Many itemized deductions have also been eliminated. You cannot claim moving expenses (except for military personnel), alimony payments (for divorces signed in 2018 and after), casualty and theft losses (only federally-declared disaster losses can be claimed), and more.
v. The deduction on mortgage interest is now limited to just the first $750,000 of the loan.
Only $10,000 can be claimed for state and local taxes. Taxpayers need to make a choice between property taxes and income or sales taxes. This will be harmful to states with higher tax rates, like California and New York.
vi. The estate tax exemption has been doubled to $11.2 million for single filers and $22.4 million for joint filers. This largely helps the top 1 percent population (4,918 taxpayers) of the country.
vii. The Child Tax credit has been increased to $2,000 form $1,000. This can be claimed by parents even when they do not earn enough to pay taxes (up to $1,400).
viii. For every non-child dependent, one can claim $500 credit.
ix. The Obamacare tax has been revoked by the Act for those without health insurance in 2019. The government saves billions by not having to pay subsidies, but this means the costs of health care will rise and fewer people would get the care they need as they won’t be able to afford the expensive visit to the emergency room. Also, health insurance companies will lose money as healthier people drop coverage which leaves more sick enlisted.
i. The maximum corporate tax rate has been reduced from 35% to 21%. This is a record low percentage since 1939.
ii. The standard deduction rate for pass-through businesses has been increased to 20%.
iii. Businesses can deduct the cost of depreciable assets in one year, rather than amortizing them in several years. The equipment must be bought between September 27, 2017, and January 1, 2023. This does not apply to structures.
iv. It eliminates the corporate AMT (alternative minimum tax).
v. The Act hardens the rules for carried interest profits.
vi. It cuts down the deductions of client entertainment to zero. Only 50% remains for qualified client meals.
There are many more ways in which the new tax code affects us. A fact to remember: Business tax cuts are permanent while individual tax cuts expire in 2025.
The impact of this change on the economy is a regressive one. Tax rates may be lowered for all, but they are lowered most for those who pay the highest taxes. Different reports estimate the cost of this bill differently as it adds to the deficit and affects economic growth.
Taxpayers have mixed reviews which may reflect how their taxes got affected. Those who owe more will obviously have negative views about it and vice-versa. As the new code is here to stay for a while, let us work on our tax planning for this year and focus more on appropriate withholdings to help us in the years to come.